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Jason M. Tyra, CPA
Jason M. Tyra, CPA, Certified Public Accountant (CPA)
Category: Tax
Satisfied Customers: 178
Experience:  Principal at Jason M. Tyra, CPA, PLLC
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I am preparing a 1065 return company that posted a loss

Customer Question

I am preparing a 1065 return for a company that posted a loss that's greater than the capital account balance at year-end. The LLC agreements specifies that the net loss allocated to each member shall not cause a member to have an adjusted capital account deficit at year-end. What do I do with the excess loss then?
Submitted: 1 year ago.
Category: Tax
Expert:  Jason M. Tyra, CPA replied 1 year ago.

You still allocate the loss based on the membership agreement. Basically, what that clause means is that a member's basis in a partnership cannot be less than $0. Whether a partner can deduct his loss is determined at the individual return level, not at the partnership return level.

See the instructions for Partner K-1 forms here-

Customer: replied 1 year ago.
What if the agreement specifically says that the LLC's net loss cannot be allocated to create a deficit in any member's account?
Expert:  Jason M. Tyra, CPA replied 1 year ago.

You might want to check with the partners to see what their intent was there. Items of income and loss cannot be allocated "nowhere." Unless they have items of loss that they want to drop off the return (thus increasing taxable income for the partners), one or more partners may end up with negative capital.

Usually, the only way that a capital account can show a negative balance is if the partnership borrowed money. One reason that an operating agreement would specify that members' capital accounts cannot fall below zero is to ensure that partners who lent money or contributed capital disproportionately are able to benefit from the expenses covered by their capital. Also, if there is a clause in the operating agreement that says that negative capital triggers a capital call, then that might be another reason why the partners are concerned about this. One of the strengths of the partnership form is that items of income and loss don't automatically have to be allocated according to ownership interest, as long as the allocation methods that you choose have economic substance.

If I were in your position, I would read the operating agreement entirely and then check with my client for intent. No matter what the agreement says, the result for you and the taxpayer can't be a null set that prevents the completion of a return.

Customer: replied 1 year ago.
Thanks, Jason. Before your last response, I realized one of the partners lent money to the partnership. I think they are allowed to claim the loss since it doesn't exceed their basis (money invested as well as money lent) in the partnership, right?
Expert:  Jason M. Tyra, CPA replied 1 year ago.

You can do a special allocation for that as long as the operating agreement allows it (or at least doesn't forbid it).

Customer: replied 1 year ago.
Thanks, Jason!
Expert:  Jason M. Tyra, CPA replied 1 year ago.

You are most welcome. If this was helpful, please don't forget to rate!